Hot Off the Web– February 9, 2010

Personal Finance and Investments

In the Financial Post’s “Know your marginal effective tax rate” Jamie Golombek explains difference between the generally well understood ‘marginal tax rate’ (“the amount of tax you pay on an additional dollar of income above a certain amount”), ‘average tax rate’ (“amount of tax you pay divided by your total income”) and the ‘marginal effective tax rate (METR)’ ( “amount of tax paid on an additional dollar of income…also including the impact of tax deductions, credits and income tested government benefits”. METR can vary wildly from zero to negative to high positive. “The clawback of the OAS alone can produce METRs of well over 50%, depending on your income and province of residence.” Golombek refers to very interesting province by province METR charts of the C.D. Howe Institute report “Comparing the marginal effective tax burdens on RRSPs and TFSAs”.

Jonathan Chevreau has a long TFSA-related Q&A in the Financial Post’s “TFSAs: Readers still confused” that you may find of interest and another on the same subject in “A no-brainer for retirees”.

Tim Cestnick on the Globe and Mail article “Six pitfalls to avoid to get the most from your RRSP” list RRSP pitfalls such as: (1) putting stocks into RRSP and fixed income in taxable account, (2) “making withdrawals to pay short-term debt, (3) capital loss will be denied when transferring assets which declined in value, (4) neglecting beneficiary designation,

Jonathan  Chevreau in the Financial Post’s “”I need $1 million to retire” and 5 other popular retirement theories that need a rethink”quotes Dina Di Vito on retirement myths: (1) need $1M for retirement(it depends on other income sources and actual expenses), (2) need 70-80% of pre-retirement income (depends on planned annual expenses), (3) CPP/OAS (depends on desired standard of living)and company pension (if any) will be sufficient, (4) delaying retirement not much help (two extra years of work increases annual retirement income by 12.5% in example)

Paul Sullivan writes in the NYT article “Index funds, dowdy for some, get a notable endorsement” quoting Burton Malkiel that: even the “the wealthiest would have fine returns without the volatility and high fees if they simply used indexes to diversify their money across asset classes”, asset allocation is the most important decision, don’t try to time the market, fees are critical, hedge funds are not for individuals. There are dissenters mentioned, but I would go with Malkiels’s approach.

In the NYT’s “Questions to ask before buying disability insurance”Ron Lieber has a great list of questions to consider before buying, pertaining to: percent of income (commissions/bonuses?) replaced, increasing with income, taxable payout, maximum dollars or years/age payout, cancellation risk, waiting period, can do work while collecting disability, disability triggers, etc.

Real Estate

Florida’s homesteaded property owners are expected to be complaining in the coming year about property tax increases despite the decline in property values according to “Blame it on SOH: Despite home-value plummet, assessments going up”. Those whose assessed property values are still below the (already 50% dropped) market value will see increased property taxes due to inflation of up to 3% (2.7% this year) of assessed value increases and expected mil rate increases. (Florida’s homesteaders’ complaints about property taxes won’t gain much sympathy from non-resident property owners who are fleeced year after year on property taxes, often paying in excess of three times as much as residents, despite the fact that they only use the facilities part time. Elimination of the dreaded Save-Our-Homes Amendment would go a long way to attract non-resident property purchases and contribute significantly to improvements in property values.)

MSNBC.com’s “State Farm cancels thousands of Florida policies”discusses State Farm’s decision to dropped 125,000 of its 714,000 Florida customers because the state denied the request for 47% rate increase. (Florida is a dysfunctional state in many ways. While regulating prices that insurance companies can charge, they don’t allow competition to work properly, and fewer and fewer companies are staying in FL thus decreasing competition and thus driving up premiums. In the meantime the state run (Citizens) insurance company is taking on the risk that private companies drop (especially for hurricane damage wind coverage), so when the next major hurricane hits, the state will be on the hook for a massive bill or even go bankrupt.)

In Canada the Globe and Mail’s Blackwell and Waldie report in “Rules governing MLS challenged”the federal Competition Bureau is challenging “the restrictive rules that govern the multiple listing service (MLS) system used by most Canadian home sellers to list their properties….It wants consumers to be able to pay a lower fee to list their homes on MLS without being forced to buy a whole range of other services. This would essentially allow homeowners to use MLS for a small fee, then negotiate the sale of their homes without the help of an agent. I f these changes come to fruition, the cost of buying and selling residential real estate could drop sharply. “

Not just the Canadian papers are full of warnings about a Canadian real estate bubble but the WSJ’s Phred Dvorak’s “Housing rebound in Canada spurs talk of a new bubble” article puts it in context with an eye-opening chart showing the U.S and Canadian house price indexes over the last decade. The U.S. index peaked in mod 2006 at around 100% increase and has since dropped to a level about 50% higher than in January 2000, whereas Canada’s house price index peaked in 2008 about 85% higher than January 2000, and is back at that peak after a brief hiccup last year. The bubble drivers are numerous including low mortgage rates, low down-payment requirements, and up to 35 year amortization periods. You can get a view of some of the Canadian papers discussing the bubble for example the Globe and Mail’s “Home prices on course to hit record highs in 2010”, “The making of a housing bubble” and “Big six banks urge Ottawa to tighten mortgage rules”. The financial Post also has a long list e.g. ”Price, sales records expected this year”

Pensions

USA Today’s Richard Wolf reports that “Rash of retirements pushes Social Security to the brink”.Specifically the Congressional Budget Office projects deficit in 1010 and 2011; other experts suggest that the real problems will start in 2016 or 2017 when boomers will be retiring on mass. (Are higher Social Security taxes or lower benefits on the way?)

In Benefit Canada’s “Themes and variations”, actuary Barry Gros reviews Canada’s pension crisis since 2008. He mentions many real problem areas, though he is being very generous to pension industry insiders who were significant contributors to the current state of affairs. For example he mentions fragmented regulation but not the toothless regulation (and its similarly toothless enforcement). He mentions the failure of going concern and solvency valuations as means of protecting DB plan beneficiaries, but no mention of the built-in conflict of interest of the actuarial profession and their failure to act as fiduciaries to protect pensioners. Mr. Gros also mentions the lack of pension insurance in Canada and that pension underfunding victims become unsecured creditors, but missed the opportunity to endorse the necessary changes in Canada to be in step with other developed countries. Mr. Gros also missed opportunity to table at least a straw-man of solutions.

Numerous articles in the last couple of days trumpeted the ‘help’ of the Ontario government to backstop its PBGF which promised to guarantee the first $1,000/mo of pension (see  “Ontario loans to cover part of Nortel pensions” , “Nortel pensioners get vow of help from Ontario finance minister” and “Benefits extended to Nortel ex-employees”) My understanding is that the PBGF was created by Ontario, the insurance premium levels were set by Ontario, the regulations were defined and overseen by Ontario, therefore what the Ontario minister has announced is nothing more than that they’ll make good on their obligations. (Those interested in Nortel pension issues could also read Bert Hill’s Ottawa Citizen articles “Nortel pensioners lobby for protection” and “Nortel pensioners’ representatives accept big cuts to buy time” )

In the Vancouver Sun article “Pension reform can’t wait for country’s economy to improve”Craig McInnes challenges apparent back-pedaling on the urgency of Canadian pension reform by B.C. finance minister Hansen on account of the recent economic problems. The argument seems to be about whether employers are capable of absorbing additional costs in this economic downturn. McInnes rightly calls this short-sighted. (In fact it is not just short sighted, the argument based on the state of the economy is a red herring; who pays is important but the most important part of the pension reform is not about who pays for it, but rather about how the funds are collected, invested and then used in retirement.)

Things to Ponder

Jason Zweig in WSJ’s “Will we ever again trust Wall Street?” suggests that to restore faith: Wall Street firms must admit their shortcomings and “financial advisers need to be much less dogmatic and confident in their predictions. By admitting the extent of their own ignorance today, they would help prevent investors from feeling railroaded tomorrow.”

Pauline Skypala writes in the Financial Times’ “Reassurance for Vanguard ‘Bogleheads’”that Vanguard is looking at introducing ‘alternative’ strategies to be associated with their Managed Payout Funds aimed at retirees’ decumulation needs. Not everybody agrees (e.g. Prof. Bodie) that equities should even have a key place in one’s retirement portfolio. She concludes with “Perhaps Vanguard’s Alternative Strategies Fund will be part of a solution to the problem of how to protect retirement savings against loss, in both real and nominal terms, without sacrificing too much growth potential. More likely there is no magic formula, and Prof Bodie’s prescription, though unpalatable, is the best medicine.”

In the Financial Times’  “Learn from the past but be rooted in the present”  John Authers points out that according  Shiller’s CAPE (cyclically adjusted P/E) and ‘q’ (replacement value of company assets to current market value) the stocks at last year’s lows were not nearly as undervalued in previous bear market lows, and “so the theory goes, we now either take another dive to new lows, or perhaps more plausibly put up with many more years of lousy returns by stocks.” But some look at the data and come up with more optimistic perspectives: like bad decades are usually followed by out-sized returns. He concludes with “while history makes clear that there is a risk of another big lurch downwards for stocks and other risky assets, it does not make such an event inevitable.”

Garry Marr’s Financial Post article “Freedom 55: The whole idea is so 1980s” discusses the desirability and feasibility retirement at 55; also perhaps given recent financial market performance the more realistic target should be Freedom 65. He quotes financial planner Rechtshaffen that “”We always do a financial plan so you can find out when you are able to not work. It doesn’t mean when you should retire, but when you have the freedom to not work”.

In the Financial Times’ “What the world must do to sustain its convalescence”Martin Wolf looks at the lessons from Davos and he concludes “We have a globalised economy, but politics remains local. In times of crisis, the pressure to look after the former dominates the latter. But now we face a different task: that of convalescence and the associated return to politics as usual. Nobody can imagine that managing this transition will prove easy. But, as the global balance of power continues to shift year by year, the challenge must be met. If it is not, the global economy and global co-operation might yet founder. This is my principal lesson from Davos.”

The WSJ’s Gregory Zuckerman in “Where will markets go next?” looks at areas where we get some surprises in the coming year: (1) consensus is that energy prices will go up due to China demand, however more supply now on the way may actually take prices lower, (2) consensus is for subdued growth, but history tells us that growth is strong after a slowdown like we’ve experienced, (3) the focus is on European debt markets (Greece, Portugal, Italy), but few are watching Japan about which some have been warning for a decade, (4) conservative investors are piling into municipal bonds, just probability of blowups is increasing (e.g. California, (5) U.S. dollar may get stronger (Oh well, forecasting is difficult, especially about the future.)

And finally, the Barron’s Alan Abelson in “Out of hibernation”  refers to Paul Volker’s dictum that “the only financial innovation useful to the country in the last 20 years is the ATM.” (Not much of an endorsement of all the brilliant financial innovation of the last 20 years.)